Trusts look good for 2003

There’s been speculation recently that the strong run enjoyed by income trusts in recent years is about to end. I don’t agree. I believe there are several good reasons to expect these popular cash cows to continue to perform well through at least the first half of 2003. Here’s why.

The resolution of the short problem. One of the little-known reasons that income trusts went into a slump in November was the publication of an article by a tax expert raising the question of whether trust units could safely be used for short positions. The issue was complex, but at the core it centred on whether loaning trust units for shorting would be construed as a deemed disposition for tax purposes, thereby triggering capital gains liability. The matter was taken so seriously that the big brokerage firms suspended short trading in income trust shares and required outstanding positions to be covered. That dried up market liquidity to some degree.

A delegation from the Investment Dealers Association went to Ottawa in a bid to get the matter clarified on a priority basis. Last week they got their answer: a comfort letter from Department of Finance confirming th trust units are indeed eligible for shorting without incurring capital gains tax. The brokerage community breathed a sigh of relief. One less problem to worry about.

A roll-back of new issues. In November, Paul Bloom, who runs the Citadel funds, and other institutional investors announced a buyer’s strike to protest the flood of new income trust issues that were depressing the market. It’s worked. The gusher has been capped. Several proposed IPOs have been downsized, postponed, or cancelled entirely.

The latest casualty, announced in early December, was the Alberta Newsprint Fund, a spin-off from West Fraser Timber. The company said it was being postponed until 2003, but you can bet it won’t resurface until such time as the underwriters are sure that it will receive a warm reception from investors. It can cost up to three-quarters of a million dollars to bring a new issue to market, and pulling it means the prospectus must be refiled. That’s a costly and time-consuming prospect for the promoters.

Improved terms. Another effect of the buyer’s strike has been an improvement in the terms of new offerings. For example, the yield on the Consumers’ Waterheater Income Fund, a new offering, was originally expected to be in the 9 per cent to 9.5 per cent range. It had to be increased to 10.5 per cent in the final pricing, and the size of the offering reduced.

Next page: A changing interest rate outlook

A changing interest rate outlook. One of the main contributors to the pull-back in the price of trusts in recent months was an expectation that interest rates would rise in 2003 as the economy recovered. Now the experts aren’t so sure about that. Bay Street economists are split on where we’re going with some predicting that rates may actually be lower at the end of next year.

Income trusts are highly interest-sensitive. When rates rise, market prices of the trusts tend to fall, and vice-versa. If rates do indeed fall in 2003, or even hold stable at current levels, some of the current trust yields look very attractive.

These are all good reasons to look closely at the income trusts marketplace right now, and there could be more positive news in the pipeline. Any move to place trust units under the umbrella of limited liability would be a big boost, as it would remove one of the impediments to institutional buying. Some intense lobbying to achieve this end is currently taking place at various levels of government.

Overall, the outlook for the income trusts market looks positive as we move towards 2003. But that doesn’t mean that all trusts are good buys. There are some excellent choices available, but there are dogs out there as well. So be selective and consult with your financial advisor for guidance.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that features sound financial advice from some of Canada’s top investment experts. To take advantage of a special risk-free three-month introductory offer for only $19.97, go to